Unraveling Deferred Annuities: Your Key to Future Financial Security

Explore the benefits and intricacies of deferred annuities as a reliable instrument to secure your financial future and bolster retirement income.

A deferred annuity is a contract with an insurance company that promises to pay the owner a regular income, or a lump sum, at some future date. Investors often use deferred annuities to supplement their other retirement income, such as Social Security. Deferred annuities differ from immediate annuities, which begin making payments right away.

Key Takeaways

  • Future Income Assurance: A deferred annuity is an insurance contract that promises to pay the buyer a regular income or a lump sum of money at some date in the future. Immediate annuities, by contrast, start paying right away.
  • Versatile Options: Deferred annuities come in several different types—fixed, indexed, and variable—which determine how their rates of return are computed.
  • Penalty Awareness: Withdrawals from a deferred annuity may be subject to surrender charges as well as a 10% tax penalty if the owner is under age 59½.

Understanding the Mechanics of Deferred Annuities

There are three basic types of deferred annuities: fixed, indexed, and variable. As their name implies, fixed annuities promise a specific, guaranteed rate of return on the money in the account. Indexed annuities provide a return that is based on the performance of a particular market index, such as the S&P 500. The return on variable annuities is based on the performance of a portfolio of mutual funds, or sub-accounts, chosen by the annuity owner.

All three types of deferred annuities grow on a tax-deferred basis. Owners of these insurance contracts pay taxes only when they make withdrawals, take a lump sum, or begin receiving income from the account. At that point, the money they receive is taxed at their ordinary income tax rate.

The period when the investor is paying into the annuity is known as the accumulation phase (or savings phase). Once the investor elects to start receiving income, the payout phase (or income phase) begins. Many deferred annuities are structured to provide income for the rest of the owner’s life and sometimes for their spouse’s life as well.

Types of Deferred Annuities

  • Fixed Annuities: Promise a specific, guaranteed rate of return.
  • Indexed Annuities: Provide returns based on the performance of a market index.
  • Variable Annuities: Depend on the performance of selected mutual funds or sub-accounts.

Strategic Considerations

Deferred annuities should be considered long-term investments because they are less liquid than, for example, mutual funds purchased outside of an annuity.

Most annuity contracts put strict limits on withdrawals, such as allowing just one per year. Withdrawals may also be subject to surrender fees charged by the insurer. In addition, if the account holder is under age 59½, they will generally face a 10% tax penalty on the amount of the withdrawal. That’s on top of the income tax they have to pay on the withdrawal. Before purchasing an annuity, buyers should make sure they have enough money in a liquid emergency fund.

Buyers should also be aware that annuities often have high fees, compared with other types of retirement investments. Fees can also vary widely from one insurance company to another, so it pays to shop around.

Finally, deferred annuities often include a death benefit component. If the owner dies while the annuity is still in its accumulation phase, their heirs may receive some or all of the account’s value. If the annuity has entered the payout phase, however, the insurer may simply keep the remaining money unless the contract includes a provision to continue paying benefits to the owner’s heirs for a certain number of years.

Related Terms: Immediate Annuity, Fixed Annuity, Indexed Annuity, Variable Annuity, Accumulation Phase, Payout Phase, Liquidity, Surrender Fee, Death Benefit.


  1. Internal Revenue Service. “Topic No. 558 Additional Tax on Early Distributions From Retirement Plans Other Than IRAs”.
  2. Financial Industry Regulatory Authority (FINRA). “Annuities”.

Get ready to put your knowledge to the test with this intriguing quiz!

--- primaryColor: 'rgb(121, 82, 179)' secondaryColor: '#DDDDDD' textColor: black shuffle_questions: true --- ## What is a deferred annuity? - [x] An insurance contract designed to provide payments at a later date - [ ] An immediate cash payout from an insurance policy - [ ] A type of life insurance policy - [ ] A form of pension plan offered by employers ## Which of the following is a characteristic of a deferred annuity? - [x] Accumulation phase where funds grow tax-deferred - [ ] Immediate disbursement of funds upon deposit - [ ] Mandatory withdrawal before the age of 59.5 - [ ] Contributions are tax-deductible ## When does the payout phase in a deferred annuity typically begin? - [ ] Immediately upon purchase - [ ] On the policyholder's death - [x] At a future date selected by the policyholder - [ ] At the end of each calendar year ## Which type of deferred annuity allows for investments in variable sub-accounts? - [ ] Fixed annuity - [ ] Immediate annuity - [x] Variable annuity - [ ] Indexed annuity ## What are tax implications of the growth in a deferred annuity? - [ ] Gains are taxed annually - [ ] Gains are tax-free - [x] Gains are tax-deferred until withdrawal - [ ] Gains are taxed at a fixed rate ## What is an advantage of a deferred annuity? - [ ] Guaranteed immediate income - [x] Potential for tax-deferred growth - [ ] Mandatory annuitization after contribution - [ ] No penalties for early withdrawal ## Are there any penalties for early withdrawals from a deferred annuity prior to age 59.5? - [x] Yes, a 10% IRS penalty applies - [ ] No, you can withdraw anytime without penalties - [ ] Only for variable annuities, not fixed ones - [ ] Only for withdrawals exceeding contributions ## Which of the following phases comes after the accumulation phase in a deferred annuity? - [x] Distribution phase - [ ] Liquidation phase - [ ] Conception phase - [ ] Savings phase ## How is the surrender period related to a deferred annuity? - [ ] It does not apply to annuities - [x] It's a timeframe when withdrawal penalties may apply - [ ] It denotes the period payouts begin - [ ] It refers to the age at which annuity contributions must stop ## Can a deferred annuity be converted to immediate annuity payouts? - [ ] No, it's not allowed - [x] Yes, during or after the accumulation phase - [ ] Only if the annuitant is over 70 years old - [ ] Yes, but only with fixed annuities